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Getting Today's Best Returns from a Home
Renovation
It's a much different picture renovating a home in 2007 than
in 1997. Fueled by huge gains in the price of real estate,
homeowners a decade ago were tapping home equity with little
care since prices were expected to keep climbing, more than
covering the cost of such improvements.
Today, with the slowdown in real estate and the widening
damage in the subprime loan market, home prices aren't rising
much — and falling in some places. And lenders tend to be a lot
choosier these days about who to do business with. So before
considering a home renovation, it makes sense to make sure your
financial house is in order:
Start with your credit report. If you're considering
borrowing, make sure your credit report and payment records are
in the best possible shape. As in most economic crises, lenders
go from being permissive to squeamish in an instant, so even
people with good credit behavior are going to be under the
microscope. Start by checking your credit report. You have the
right to get all three of your credit reports — from Experian,
TransUnion and Equifax — once a year for free. You can do so by
ordering them at www.annualcreditreport.com,
but do so at staggered times throughout the year so you can
catch potential errors in your report as they happen. Also, if
you need to clean up any bad behavior — late bills, heavy credit
card debt, clean it up before you wander back into the real
estate market. Remember that a bad credit score can raise the
total cost of your mortgage.
See what kind of payoff your chosen renovation will have.
During the housing boom, people thought virtually any renovation
would offer big returns. That wasn't true then, and it's
particularly untrue now. Take the time to figure out what
renovations have the best chance for return on investment now —
go to Remodeling magazine's annual Cost vs. Value report online
(http://www.remodeling.hw.net/content/CvsV/CostvsValue-project.asp?articleID=381305§ionID=173)
and check 2006 project cost averages for your region of the
country. In this market, renovate because it's going to bring
you comfort or pleasure, not because you're expecting immediate
profits.
Know how long you'll need to stick around. When you
sell, remember that most married couples can exclude from their
taxable income up to $500,000 of gain and most individuals
filing single or married filing separately can exclude up to
$250,000. It's required that you must have owned and used your
home as your principal residence for two out of five years
before the sale. The exclusion is generally applicable once
every two years. However, if you are unable to meet the two-year
ownership and use requirements because of a change in
employment, health reasons or unforeseen circumstances, then
your exclusion may be prorated.
Beware the bump in property taxes. The great thing
about a more valuable home is the potential higher value when
you sell. The bad thing is a visit from the county assessor — more valuable property tends to lead to higher tax assessments.
Make sure you cannot only afford the cost of renovation, but
what you'll need to pay higher taxes if your home is reassessed.
Don't forget to deduct applicable sales tax. If sales
tax was imposed on a major renovation or if your state or
locality imposes a general sales tax on the sale of a home or
the cost of a substantial addition or major renovation, you
might be able to deduct it. This alternative is particularly
valuable in low-tax states, and the sales tax paid on the
purchase of some large items including the purchase of a home or
major addition can be added to the table amounts.
Make sure your renovation makes your home salable. A
discussion with a real estate agent or someone familiar with the
value of improvements in your immediate neighborhood can tell
you what will add to value or take it away. For instance, a big
addition can take away from the value of a home if it's not
aesthetically in tune with the rest of the neighborhood.
Obviously, any renovation that keeps your house on the market
longer better be worth it now because it might damage your sales
prospects later.
January 2008 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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